In Sanofi-Genzyme Deal, Both Sides Are Dancing Around Bad Information

Last Updated Oct 26, 2010 12:47 PM EDT

The haggling between Genzyme (GENZ) and Sanofi-Aventis (SNY) over whether the former is worth $69 or $89 per share in an acquisition illustrates a classic management dilemma: How to make big strategy decisions based on incomplete -- or even bad -- information.

There's lots of incomplete and bad information washing around in the dance between Genzyme CEO Henri Termeer and Sanofi boss Chris Viehbacher. In fact, both companies' official negotiating positions are based on untestable guesswork. One or both of these companies will eventually find out that its assumptions are completely wrong, but only when it's too late: Sanofi's offer expires on Dec. 10.

Here are the details of each company's math:

  • Sanofi's offer of $69/share is a 38 percent premium on the stock prior negotiations. It's also 19 times Genzyme's estimated 2011 earnings per share, Sanofi said in an investor presentation describing the logic of its offer. That slideshow also notes that it values genzyme's new multiple sclerosis drug, Campath (alemtuzumab), at $700 million in peak revenues per year.
  • Genzyme says $89 is the proper price because, if you apply Sanofi's EPS multiple to "the midpoint of Genzyme's 2011 guidance" you get $89. Genzyme's investor slideshow also shows alemtuzumab revenues peaking at $3.5 billion a year.
The first thing to notice is that both Sanofi and Genzyme are basing their prices on guesses about EPS in 2011. They're also guessing about revenues of alemtuzumab, which isn't on the market yet and won't be until 2012. They then mix that guesswork with some facts that actually exist -- Genzyme's current financials -- and engineer a price based on the mixture.

This is a key mistake many managers make: Assuming that if you mix good information (what you know today) with bad information (guesses about tomorrow) that the result will be a reasonable average of the two. This is nonsense. The opposite is true: Polluting good information with bad information only serves to completely pollute the good information. This is especially true if the information involves multiples and exponentials, such as the discount rates, interest rates, and time periods often involved in calculating future cashflows. A small error in such calculations will magnify into an outsize error in the final result. (Goldman Sachs made just this error in calculating the value of Genentech in that company's acquisition by Roche.)

Yet both companies' offers rely on such guesses. Both the $69 price and the $89 price are entirely dependent on assumptions about stuff that might happen in 2011, rather than stuff both companies know to be true today.

Separately, you don't have to understand the math of corporate finance to know that both Sanofi and Genzyme's estimates about the revenue potential of alemtuzumab are more likely to be wrong than right. Sanofi has picked the median estimate from a set of seven Wall Street analyst estimates that range from $1 billion to $370 million:

Genzyme's estimates are based on its own guesses compared with an "independent advisory firm," which makes similarly lofty claims:

The median is not the same as the average or even the "expected return" of an investment asset for which there are several different scenarios. If Sanofi had at least done those calculations, the risk of its estimate being wrong would at least have been weighted into its estimate.

And even if that were the case, such a weighting gives you the answer in only one future scenario: The scenario in which alemtuzumab earns $700 million a year (or in the case of Genzyme, $3.5 billion a year). We know from both presentations that there are at least nine educated guesses about the drug's future revenues, ranging from $370 million to $3.5 billion. And we know for sure that only one of those scenarios will unfold in the future (or at least, that one of those guesses will be closest to what actually happens in the future). So eight of those guesses will definitely be wrong.

In other words, there's only a 9-1 chance that either Sanofi or Genzyme have priced alemtuzumab's future revenues correctly.

Interestingly, the market seems to believe Sanofi more than it believes Genzyme. The stock price is currently hovering just above $70, indicating that investors do not believe Sanofi is about to capitulate to Termeer's demand for $89:

There's a lot of information out there about the current condition of both companies today. Investors have had time to digest it. And they're indicating what they believe is a fair price for Genzyme today, right now, based on that information. In fact, today's price falls squarely under the "good info" category of things we know to be true. If Termeer and Viehbacher are reasonable people, we should see the deal close somewhere near $72.